According to data from the Securities and Exchange Board of India, funds raised in Category II AIFs — mutual funds that can only invest in unlisted companies — from investors rose from Rs1.24 lakh crore in March 2020 to ₹2.40 lakh crore in June 2022. AIFs cannot accept less than ₹1 crore from each investor.
Wealthy investors prefer these over debt mutual fund schemes betting on lower-rated securities because of higher returns and tailored structures.
Ravi Vukkadala, CEO, Northern Arc Investments, said, “The AIF structure outperforms mutual funds as it can be tailored to cover the volatility of the society or the day-to-day supply shortfalls.
Mutual funds have been reluctant to invest in lower-rated paper after a series of defaults by issuers over the past two years, leading to erosion of earnings. This has led to mutual funds taking more than investors. According to data from Morningstar research, only 0.3% of the debt industry’s AUM is in ‘A’ and below paper, with up to 96% of its assets being AAA-rated paper.
“After the 2020 liquidity crunch, asset managers are mostly focused on high-quality paper,” said Kaustubh Belapurkar, director at Maledastar India.
These debt AIFs should provide higher returns than mutual funds because of the less favorable tax benefits that mutual funds enjoy. “Investors need to earn at least 200-300 basis points higher to offset the additional risk after tax,” says Munish Randev, founder, Servin Family Office. While debt mutual funds can offer returns of 7-7.5% before expenses and taxes, financial planners believe investors should get a debt AIF of at least 14-16% for the expenses, higher taxes and risk.
Sarabh Jalaria, CIO of Alternative Credit Strategies at InCred Asset Management, says, “We look at private equity, new-age technology business-backed companies and disruptive companies. Jalaria believes that there are good opportunities in fintech for small ticket users and in the electric vehicle space.
Some AIFs for new age technology companies and disruptors in the private credit space may seek funding over a period of one to three years.
Most of the companies that lend to AIFs are banks and mutual funds that refuse to touch the barbell.
“The unmet structured credit needs of small and mid-sized corporates creates an attractive opportunity for a debt fund focused on their needs,” said Vikas Sachdeva, director, Sundaram Alternative Management. His fund targets mid-sized companies across a diversified spectrum with an average internal rate of return (IRR) of 16-17 percent.
Given that high returns bring high risk, investors should go with asset managers that have been through multiple cycles. “Before we give a loan to a company, we look at parameters like management, cash flow, board structure, track record of promoters, auditors and so on,” Vukadala said.